Tuesday, September 23, 2008

The Financial Bailout and its Implications

Enough has been said already about greed, big salary and bonus payouts to senior executives of banks. The situation is where it is - precarious and needs to be addressed urgently. Treasury Secretary Henry Paulson has been running around for the last couple of weeks trying to avoid a 1929/30 style financial meltdown and all credit to him for his deft handling of the situation so far.

The current proposal before the Congress is to approve an emergency fund of $800 billion (with no apparent upper limit) to be managed by Treasury Department to buy toxic mortgages and exotic paper from banks for cash in order to provide liquidity to financial institutions. Despite the loud protests of Congress, almost everyone knows that this bill will pass and funds will be made available.

Congress may wish to place an upper limit, so this does not become an open ended commitment. Paulson himself suggested in the weekend talk show interviews that amount needed could exceed $1 trillion. This is almost equal to the amount spent on Iraq war to date. So wither plans of ending the war to save money to spend on social programs.

The Congress should also consider putting a mechanism in place that any bank benefiting from this fund will agree to freeze the salaries and bonuses of top 5% executives until such time as the treasury holds their toxic paper. Once the paper is sold, the restriction is lifted. Also, Congress should consider setting up a three member committee of reputable citizens with financial experience who will approve any bonus payments to top 5% executives of banks and financial institutions benefiting from this fund. This may seem draconian, but it is important to give a sense to tax payers that bankers will not start paying themselves huge bonuses until such time as their money is tied up in toxic assets.

The wider implications of the bailout are much greater. The national debt already ballooning out of control will exceed $11 trillion. No one knows how this will ever be paid down or how many decades it will take to bring it down to the level it was eight years ago. Treasury will probably end up printing more money and that could cause serious inflation, erosion in value of dollar and a possible shift from Dollar to Euro as the world currency. High inflation will result in high wage demands by unions, resulting in even greater inflation, mortgage foreclosures and credit card debt defaults.

I hope Paulson and Bernanke are considering all those eventualities and are ready to tackle what is to follow.


dwrightsman said...

I am opposed to the term bailout. What is good for the goose is good for the gander. I believe the entire relief package should be a loan from the tax payers not a bailout. So, the taxpayers cover the loan, the recepients of the loan return the funds with interest to the taxpayers. I know when I am in a financial bind.., if I go to a bank for relief I dont get a bailout, nor is one offered. Why should this situation be treated any differently?

Ajaz Haque said...

You make an absolutely valid point. However, the problem with loaning money to banks is that under the Basel formula their capital requirement goes up even more and as is they are short of capital. Buying toxic assets provides them liquidity without increasing capital requirements and allows them to continue with the lending business without which the credit system could freeze up.

Also, it depends what price Treasury buys these assets. If these are (say) 20-30 cents in the dollar then there is a chance the tax payers could ultimately make a profit. But there is no guarantee of that, hence tax payers are indeed at risk.

pete said...

This unprecedented money-grab by Big Finace at the expense of the American Taxpayer is criminal. Let those greedy companies that have profited for years with outrageou fees, high payments and shell-game accounting take the losses. There is no financial crisis. Mumbles Paulson & Helicopter Ben are mouthpieces for Big Finance and lie routinely. Americans are smarter than this and should vote this Nov. accordingly. This is but another failure of the worst period of American history in my generation thanks to Bush. He is a historical failure - college, military, business & politics. The Bush Administration has hurt this great country more than Al-Quida can ever do. Absolutely shameful ..... and sad.

Ajaz Haque said...

There is absolutely no doubt that damage caused by Bush and his bunch of war criminals to America and the rest of the world is enormous and perhaps irreparable. And yet 40% of Americans are prepared to vote a Republican into office. Isn't that just amazing?